Business failure has historically been a risk insurance carriers have assiduously avoided. Other than trade-credit insurance and limited credit-enhancement policies, the risk of default of a business is typically borne by the business owner.
In today’s lending environment, as banks look to mitigate their own exposures to risk, nearly all small and midsize business owners must sign a personal guarantee to secure financing. The result is that, if the business fails, the business owner’s personal assets are used to cover the loss.
This is obviously an extremely angst-inducing, emotionally charged decision, which, if it ends badly, can cause significant hardship — including loss of the owner’s home.
But with the introduction of personal guarantee insurance, a new category of coverage is now available to help business owners manage personal risks — and sleep better at night.
Smart Business spoke with Sergio Bechara, president and CEO of Millennium Corporate Solutions about how personal guarantee insurance works, how it can help business owners, and what features to look for in this coverage.
What is a personal guarantee?
A personal guarantee is essentially a signed blank check without an expiration date. But with the introduction of personal guarantee insurance, business owners can manage their personal risks — and enjoy the peace of mind that comes with knowing their personal assets will not be used to cover the loss if their business fails.
Why is personal guarantee insurance important?
Insurance practitioners are the guardians of their clients’ assets, both personal and professional. They manage, mitigate, isolate, insure and have contingency plans if bad things happen.
As part of that task, they work with lawyers to create barriers to limit liability through corporations, LLPs, LLCs and trusts. For remaining liability exposures, there is general liability, auto liability, professional liability and a host of other coverage types, all of which are used in the name of protecting assets. For property exposures, the insurance practitioners negotiate special forms coverage for their clients.
Despite the great efforts of the insurance carriers, underwriters and brokers, bankers can destroy much of their good work with one stroke of the pen. In their efforts to mitigate their own risk exposure, banks have penned personal guarantee requirements that tie the business owner’s assets to the business itself. These requirements, which most small and midsize business owners must meet in order to receive financing, have the effect of taking down the walls your insurers have so diligently erected, allowing for the unthinkable.
Since a personal guarantee gives the banker access to a business owner’s personal assets (often including a spouse’s) if a business loan is in default, bankers have traditionally had the upper hand in these situations — until now.
How does personal guarantee insurance help business owners?
Personal guarantee insurance (PGI) helps neutralize the impact of the required guarantee. It puts back the wall between the business and personal assets by covering a substantial portion of the liability of the personal guarantor in the event the loan guarantee is ever called.
With this policy, everyone can be satisfied: the bank receives the personal guarantee to complete the loan, while the client’s personal assets are protected by the insurance policy.
As a benefit to bankers, one provision of the PGI policy is that the proceeds can be assigned to the lender, thereby improving the collateral position of the bank. Now, the bank has an even better position — it has the business as collateral and a signed personal guarantee, which is backed by an insurance policy to which it is a beneficiary.
What features should business owners expect as part of this coverage?
Some features of the new insurance are:
- PGI is typically issued within six months of a loan origination or material modification.
- It can be designed to pay up to 70 percent of a deficiency judgment in the event of a loan default.
- It can typically be underwritten based on the same information the bank uses when making the business loan.
- While it adds cost to the overall loan transaction, it provides a tremendous backstop in the event personal assets are ever called into play.
- Since the bank is likely in a better position if the proceeds are assigned to the lender, it may be able to offer a more attractive interest rate on the loan once the coverage is put into place to help offset the cost of the insurance.
How can insurance brokers and risk managers ensure the personal guarantee insurance is working as it should?
As we undertake the managing of risks for our clients, a review of the personal guarantee should be included in exposure-review checklists, just like we review employment practices, environmental or cyber-liability exposures.
Sergio Bechara is president and CEO of Millennium Corporate Solutions. Reach him at (949) 679-7120 or email@example.com.
It’s a reality of business today: many of the products sold in the U.S. are part of a global supply chain. There is even a debate surrounding what percentage of a product has to come from the United States in order to be labeled “Made in the U.S.A.”
“Unless they are very small, most manufacturing and distribution companies in the U.S. are involved with at least one other country,” says Debra F. Scalice, vice president, Millennium Corporate Solutions.
“Importing from China alone has increased from $109 billion in 2001 to $365 billion today — that’s huge; almost a 300 percent increase. Obviously the removal of U.S. manufacturing jobs has had multiple impacts, and among these is increased international risk,” Scalice adds.
Unfortunately, she says, many U.S. companies are not fully cognizant of the consequences that may occur if they are not covered properly while conducting business with and in other nations.
Smart Business asked Scalice about some of the exposures businesses face and what they can do to minimize them.
Why is international risk such an important topic right now?
Many U.S. manufacturers are fighting to stay alive and they are often resorting to smaller, niche markets, leaving their old product skews behind and innovating new products or parts, which are imports. They must change or face extinction via lack of competitive price points. Nearly all U.S. companies are involved to some degree with importing or exporting. All too often, U.S. companies think they are protected from various liabilities when in reality they are not. It is easy to misinterpret your coverage. Countries have very specific mandates about the types of coverage you need to have and who is legally able to provide that coverage — Mexico is a good example. If you don’t have a Mexican insurance company and something goes wrong, you’re going to jail.
What are some of the risks involved with property exposure?
Typically, international property exposures are similar to domestic exposures. You need to know where the property is located, whether there are any nationally mandated coverages, availability of coverage subject to increased hazards, if the property is adequately covered while in transit, and if you are using the shipper’s coverage or purchasing your own.
Are there any time constraints regarding the arrival of your property? What if the goods arrive at the harbor and half of the product isn’t there? Or, has the product been substituted using trickery? What level of risk are you prepared to take on yourself? On the other hand, if you are exporting, what happens if the companies you are exporting to owe you money and disappear? Can you handle the financial loss or will you need credit insurance?
What key factors about liability exposure do companies need to be aware of?
If you’re manufacturing in the U.S. and your policy says you have worldwide coverage and protection, don’t let that lull you into a false sense of security. It probably means you’re only covered for lawsuits initiated in the U.S. Let’s say you sell something in Europe and someone gets hurt. You think you have worldwide coverage, but if you don’t have proper international liability in place, there could be terrible financial consequences.
Liability exposure for importers is another consideration. There are many domestic carriers who are not interested in covering imported products. So if you’re an importer and something goes wrong with the product you imported, you will be held accountable, as there is no domestic manufacturer to seek financial restitution from. It is very difficult to sue in other countries, which are often ‘developing.’ Who will you sue in that country? Are they even liable according to their laws? What if the products you’re bringing in and selling to your clients start to fail? This is a nuance of international business you can’t insure for, but you have to contemplate the risk.
What are some considerations for traveling overseas for business?
In today’s world, you do not want to be walking around a foreign country without proper risk assessment and coverage. Let’s say you’re a salesperson who travels to London for your boss; you and your boss decide you should live there temporarily. The employer needs to cover you for workers’ compensation in that country — it’s a human resource issue. Or let’s say you’re the CEO of your own business and you’ve excluded yourself from workers’ compensation insurance. You go to Europe and something happens to you — you have a car accident or a health event, or a political act takes place. Who will pay to bring you back to the U.S.? Kidnap and ransom are also real concerns. If you are an American traveling abroad, you are a target. There are hotter spots than others in terms of exposure, but it’s actually quite common and happens all over the world. For any executives who are traveling, you need to ensure that risk management techniques have been employed to help assure your safety and that the right coverage is in place.
How can companies ensure that they are protected properly?
Talk with your international attorney and a diligent insurance broker who will show you how to protect your interests. They will help you determine your own risk tolerance, where you are exposed, and what needs to be covered. Seek a broker familiar with international risk who will know the insurance vehicles available to cover international risk. Equally important, the broker will help you understand what is not covered. This is a very dynamic and fluid area so it’s important to keep in touch with your broker on a regular basis to ensure you are properly covered at all times.
DEBRA F. SCALICE is vice president, Millennium Corporate Solutions. Reach her at (949) 679-7139 or firstname.lastname@example.org.
The construction industry has slowed along with the economy, but it won’t be that way forever. And as things start to pick up, more projects will be at least partially funded by the federal government.
As a result, construction companies need to begin preparing now to be in a position to garner the surety bonds they will need in order to bid on public works and federal government projects, says Owen Brown, senior vice president at Millennium Corporate Solutions.
“The smart contractor will begin preparing today for the turnaround,” says Brown. “With the economy as it is, some people are hesitant to do this now because they say there is no work. But now is the time to do it so that when there is work, you are ready. The companies that have done well over the years have done so because they prepared in the down times.”
Smart Business spoke with Brown about why construction companies need to prepare themselves with a line of credit for surety bonds and how construction firms can position themselves for bond approval.
What is a surety bond?
Surety is different from insurance. The insurance company indemnifies the insured from losses for covered exposures specifically outlined in the insurance policy for a premium based upon the contractor’s claim experience and potential exposure to loss.
The principal (contractor) who pays for the bond premium, which is based on his or her credit and financial strength, indemnifies the bonding company from loss. The bond forms, unlike the insurance policy, are often prepared by the government, municipality, or owner and make the contractor and surety company responsible for the bonded contract completion, lien free. All bills must be paid in full by the contractor and/or the bonding company before the bond is exonerated.
If the surety is served with a claim or lawsuit for unpaid bills or failure to complete the contract, the contractor, at his or her own expense, defends the surety from potential loss.
What can a company do to begin preparing to apply for a surety bond?
You need to establish a good solid outside management team. Identify a surety representative who has experience putting bonds together on federal projects, who knows what forms are needed and who knows the process of the federal government. In addition, you should have a CPA firm knowledgeable about construction contracts and familiar with surety company requirements. The financial report — its format and method of preparation — is a very big part of the presentation to the surety and the surety’s decision to go forward with the contractor. You should also have an insurance agent who knows what insurance exposures you have when you undertake work for federal reservations and for cities and counties. Finally, you should have an attorney to consult with because, as these contracts grow, they become more complex.
Does a company need to provide a lot of information to a surety representative?
Yes, because he or she must determine if you have the experience and financial strength to do the work. The construction company will need to provide the resume of the owner and information on projects that the company has completed, including the project owners’ references. The surety representative will also need a list of key personnel, because if you are dealing in construction and you want to grow, you need good, experienced people. Obtaining a bond is a credit operation. Financial strength is important and the contractor will be asked for financial statements from past years as well as current financial reports, including a personal balance sheet.
You will also need to provide information about your insurance program, simply because the representative wants to make sure your family is taken care of if something happens to you. Last is a bank line of credit — how much the company can borrow. There can be hiccups in any construction project, and a bank line of credit can help you get through a crisis or a slow pay situation.
A line of credit for surety bonds can be established within a reasonable time frame if the construction firm is prepared. Preparation prior to a bond requirement is best for the contractor and the surety.
Is the process expensive?
Everything that the surety representative does to build the file and acquaint the surety with the company’s operations is done at no cost. The only time there’s a charge is when the representative writes a performance bond or payment bond on a contract. When you’re bidding a job, if there is a bid bond required, there is no charge for that. Only when you get the contract do you pay.
What would you say to a contractor who has no interest in pursuing federal contracts and says he will never need a surety bond?
Contractors, especially in tough times, have to be able to make adjustments. If you’ve been building houses for the last 10 years, and suddenly there are no houses to build, you need to stop looking for houses to build.
With the way the economy is being restructured, most of the state contracts that we’re seeing, such as public works for streets, roads and highways, are partially or completely federally funded, which means federal regulations will rule. As the state of California struggles, it is relying more on federal funds, and the federal government is getting more involved in state and local contracts. Some contractors say they don’t want to work for the federal government, but no matter who they work for, they’ve got to realize that the federal government holds the purse strings for a lot of contracts, and it requires bonds.
Additionally, people are asking for bonds that they may not have asked for in good times. Banks previously would loan money on a construction project with no bond required. Now, when they are loaning money to an owner, they tell that owner that he or she needs to get a bond from the contractor.
By getting things in order now, you’ll be prepared to bid on contracts requiring bonds.
Owen Brown is senior vice president at Millennium Corporate Solutions. Reach him at (949) 679-7105 or email@example.com.